The Economic Climb-Out for U.S Airlines: Global Competitiveness and Long-Term Viability ATA Office of Economics January 29, 2011 The Air Transport Association of America, Inc Air transport has become an essential economic and social conduit throughout the world Beyond the benefits of fast and inexpensive transcontinental travel, air transport also has become a vital form of shipping for high-valued items that need to come to market quickly… — World Bank (www.worldbank.org/airtransport) Combination Services All-Cargo Services Associate Members AirTran Airways Alaska Airlines American Airlines United Airlines* Delta Air Lines Hawaiian Airlines JetBlue Airways Southwest Airlines US Airways ABX Air ASTAR Air Cargo Atlas Air Worldwide Holdings Evergreen Int’l Airlines FedEx Corporation UPS Airlines Air Canada Air Jamaica * Includes Continental Airlines www.airlines.org OVERVIEW • Safety of commercial travel exceeds other modes and continues to improve • DOT statutory mission explicitly recognizes importance of airline industry viability and global competitiveness • A viable, competitive U.S airline industry is good for the country, fueling jobs and growth • Numerous stakeholders benefit from a financially viable, competitive U.S airline industry • Competition among airlines remains intense • Battlefield is increasingly global, with a relatively mature domestic market • U.S airlines are financially weaker than many non-U.S airlines • To reinvest in product/people, airlines need substantially improved finances • Competing in the global marketplace is essential for airlines and good for USA www.airlines.org The State of the Industry Fitch: ―2011 Outlook: U.S Airline Balance Sheet Repair to Continue‖  ―Fitch [Ratings] expects ratings for most U.S airlines to improve in 2011, reflecting a modest strengthening of industry operating fundamentals and steady progress toward debt reduction and balance sheet deleveraging As U.S carriers look to unwind the lingering effects of historically weak returns, insufficient cash flow generation, and constrained liquidity, deployment of cash toward debt repayment will be essential if the ratings momentum witnessed in 2010 is to continue for another year.‖*  Much like the U.S economy, U.S airlines are climbing out of a deep hole and have a long way to go to be financially strong: (1) attain investment-grade credit and generate a return on invested capital in excess of cost of capital through a full business cycle  U.S airlines are focused on shoring up balance sheets to reinvest in product, people and planes, and to weather the next fuel spike or economic downturn without significant reductions in personnel or service; the global aviation marketplace, where traffic growth is most promising, is increasingly relevant and intensely competitive  Restructuring has become a way of business – we’re in a period of continual reinvention * Fitch Ratings, ―2011 Outlook: U.S Airline Balance Sheet Repair to Continue‖ (Dec 9, 2010) www.airlines.org U.S Carriers: Competing in a Global Marketplace Selected M&A and/or Cross-Border Investment: 1995-Present USA Non-USA Republic/Shuttle America Air France/KLM US Airways/America West Copa/AeroRepública SkyWest/Atlantic Southeast Lufthansa/Swiss Lufthansa/JetBlue* Air China/Cathay Pacific* Delta/Northwest Cathay Pacific/Dragonair Republic/Midwest Lufthansa/Brussels*/BMI/Austrian Republic/Frontier Avianca/TACA United/Continental British Airways/Iberia SkyWest-ASA/ExpressJet LAN/TAM Southwest/AirTran LAN/Aires* Source: ATA and Deutsche Bank Global Research www.airlines.org * Strategic investment but not full ownership or control An Analyst/Investor View Source: Deutsche Bank Global Research (Jan 13, 2011) ―Consolidation, in our review, represents a later stage for a mature industry that is seeking ways to address its financial volatility… Our view is that consolidation is part of a longer-term process that should ultimately allow the global airline industry to efficiently allocate capital and assets such that a positive return on invested capital can be achieved… On the surface, airlines pursue mergers as a means to improve profitability…and their competitive positioning via an expanded network Longer-term, consolidation should improve industry viability while mitigating industry volatility and consequently lower its cost of capital.‖ Source: ―Global Airline Sector – Laying the Foundation for Global M&A,‖ Deutsche Bank Global Research (Jan 13, 2011) www.airlines.org Air Travel Safer Than Other Forms of Intercity Transport U.S Passenger Fatalities per 100 Million Passenger Miles, 1998-2007 0.75 0.04 Auto (1) 0.04 Bus (2) Rail (3) 0.01 Airline (4) Passenger cars/taxis; drivers considered passengers; data from the NSC Fatality Analysis Reporting System Does not include school buses; data from the NSC Fatality Analysis Reporting System Data from the Federal Railroad Administration (FRA) Large and commuter airlines, excluding cargo; data from the National Transportation Safety Board (NTSB) Source: National Safety Council Injury Facts® 2010 Edition, 1998-2007 averages (most recent available) www.airlines.org Each Decade, U.S Airline Safety Has Improved Markedly Fatal Accidents per Million Aircraft Departures in Scheduled Service 0.8810 0.5050 0.2919 0.1230 1970-79 1980-89 1990-99 2000-09 Source: ATA analysis of data from the National Transportation Safety Board www.airlines.org DOT Statutory Mission Explicitly Recognizes Importance of (and Role in) Industry Viability and Competitiveness U.S Code, Title 49, Sec 40101 Policy, Subsection A: ―Economic Regulation‖ (6) placing maximum reliance on competitive market forces and on actual and potential competition — (A) to provide the needed air transportation system; and (B) to encourage efficient and well-managed air carriers to earn adequate profits and attract capital, considering any material differences between interstate air transportation and foreign air transportation (14) promoting, encouraging, and developing civil aeronautics and a viable, privatelyowned United States air transport industry (15) strengthening the competitive position of air carriers to at least ensure equality with foreign air carriers, including the attainment of the opportunity for air carriers to maintain and increase their profitability in foreign air transportation (16) ensuring that consumers in all regions of the United States, including those in small communities and rural and remote areas, have access to affordable, regularly scheduled air service www.airlines.org A Viable, Competitive U.S Airline Industry Is Good for The Country, Fueling Jobs and Economic Growth “Aviation is the glue that keeps the global economy together Without widely accessible and well-priced air travel, the global economy will quickly become less global.” — Dr Mark Zandi, Chief Economist & Co-Founder, Moody‟s Economy.com (August 2008) ―The Economic Impact of Civil Aviation on the U.S Economy‖ (FAA, Dec 2009) Commercial aviation helps drive:  $1.225 trillion/year in economic activity  $371 billion/year in personal earnings  10.9 million jobs Commercial aviation contributes:  $731.5 billion/year to U.S GDP  5.2% of U.S GDP “Economic growth and prosperity are determined in large part by access to the global economy And, just as islands require bridges to the mainland….communities require bridges to the global economy Air transportation is that bridge, providing the necessary access for U.S cities…to enjoy a „Virtuous Circle of Economic Growth.‟” “The Plane Truth About Air Service and Economic Development,” Global Aviation Improvement Network, Booz Allen (March 2001) “Every day, the airline industry propels the economic takeoff of our nation It is the great enabler, knitting together all corners of the country, facilitating the movement of people and goods that is the backbone of economic growth It also firmly embeds us in that awesome process of globalization that is defining the 21st century.” — Daniel Yergin, Author, Commanding Heights: The Battle for the World Economy, in the ATA 2005 Economic Report www.airlines.org 10 Demand for Domestic Air Travel Has Not Recovered Domestic Passenger Revenue (¢) per $100 of U.S Gross Domestic Product 75 Shortfall = $34B 70 65 60 55 50 www.airlines.org 2010E 2009 2008 2007 2006 2005 2004 2003 2002 2001 1991-2000 45 Source: ATA analysis of BEA and BTS data 25 The Price of Air Travel Has Not Kept Pace With U.S Inflation The Price of Many Common Goods and Services Has Outpaced the CPI Product (Unit) Grade-A Large Eggs (Dozen) Unleaded Gasoline (Gallon) Movie Ticket Prescription Drugs (Index) First-Class Domestic Stamp New Single-Family Home U.S CPI (All Items)1 Whole Milk (Index) New Vehicle Systemwide Airfare + Ancillary Fees2 Domestic Round-Trip Airfare + Taxes3 Television (Index) 2000 $0.91 $1.51 $5.39 285.4 $0.33 $169,000 172.2 156.9 $24,923 $144.57 $339.03 49.9 2009 $1.66 $2.35 $7.50 391.1 $0.44 $216,700 214.5 183.2 $28,966 $145.17 $310.06 10.6 % Change 82.9 55.6 39.1 37.0 33.3 28.2 24.6 16.7 16.2 0.4 (8.5) (78.7) BLS ―measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.‖ BTS average airfare and ancillary fees generated per passenger enplaned, excluding government-imposed charges BTS National-Level Average Fare Series, the average domestic airfare paid per round-trip itinerary, including government-imposed charges www.airlines.org 26 The Price* of Air Travel Has Not Kept Pace With U.S Inflation $84.49 2Q10 2Q09 $301.26 $346.10 2Q08 $325.39 $306.68 2Q05 2Q07 $309.45 2Q04 $341.58 $314.52 2Q03 2Q06 $317.93 2Q02 $328.67 2Q01 $339.16 2Q00 $329.34 2Q99 $300.97 2Q98 $289.44 2Q97 $275.78 2Q96 2Q95 $296.80 CPI-Linked Prices (hypothetical) Average Nominal Prices* (actual, including taxes) $340.72 $425.21 U.S CPI Rose 43.3% from 2Q95 to 2Q10, Leaving Ticket Prices $84.49 ―Short‖ * BTS reports average fares based on domestic itinerary fares (round-trip or one-way for which no return is purchased) [Averages not include frequent-flyer or ―zero fares.‖] Fares are based on the total ticket value, which consists of the price charged by the airlines plus any additional taxes and fees levied by an outside entity at the time of purchase Sources: BTS National-Level Average Fare Series (http://www.bts.gov/xml/atpi/src/avgfareseries.xml) and BLS (http://www.bls.gov/cpi/tables.htm) www.airlines.org 27 2009 Domestic Seating Capacity Fell Most Since 1942 100 80 60 40 20 (40) (16.2) (20) Sources: ATA, BTS (T1 Scheduled Service) www.airlines.org (6.9) 1932 1934 1936 1938 1940 1942 1944 1946 1948 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Annual Percent Change in Domestic ASMs* Market Forces, Policy Resulted in Largest Post-WWII Contraction in Aviation History * An available seat mile (ASM) is one seat flown one mile 28 Capacity Being Re-Balanced With Size of U.S Economy Domestic ASMs* per $1K of Real U.S GDP** at Lowest Level Since 1979 75 70 65 60 55 50 45 40 Sources: BTS (T1 Domestic, All Services) and Bureau of Economic Analysis www.airlines.org 2014 2012 2010E 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 1978 1976 1974 35 * An available seat mile (ASM) is one seat flown one mile ** Chained 2005 dollars 29 Capacity Over the Past Decade: A Tale of Two Markets Down 11% Domestically, Up 20% to/from USA 2.89 2.64 2.74 2.66 2.49 1Q11 1Q10 1Q09 1Q08 1Q07 1Q06 1Q05 2.10 1Q04 2.05 1Q03 1Q02 1Q01 1Q00 1.94 2.23 12.76 12.51 1Q10 1Q11 12.56 1Q09 1Q06 1Q05 1Q04 2.42 14.02 1Q08 2.85 Billion International* ASMs per Week 2.41 14.02 1Q07 13.62 14.05 12.92 1Q03 1Q02 1Q01 1Q00 12.65 13.69 14.39 13.99 Billion Domestic ASMs per Week * U.S airlines only; an available seat mile (ASM) is one seat flown one mile and is the standard unit of capacity in the passenger airline sector Source: Innovata (via APG) published schedules as of Jan 21, 2011 www.airlines.org 30 Departures Over the Past Decade: A Tale of Two Markets Down 22% Domestically, Down 3% to/from USA 1,816 1Q10 1,836 1,816 1,921 1Q09 1,806 1Q06 1,864 1,811 1,669 1,654 1Q11 1Q08 1Q07 1Q04 1Q03 1Q02 1Q01 1,541 23,452 1Q11 1Q00 23,299 1Q10 23,991 1Q09 1Q08 1Q07 1Q06 1Q05 1Q04 1Q05 1,898 1,759 26,282 26,895 28,000 26,359 26,077 1Q03 26,826 25,947 1Q02 1Q01 1Q00 Scheduled International* Flights per Day 29,953 29,673 Scheduled Domestic Flights per Day * Scheduled U.S.- and non-U.S.-airline flights departing U.S airports for non-U.S destinations Source: Innovata (via APG) published schedules as of Jan 21, 2011 www.airlines.org 31 Thinking Outside the [Domestic] Box The Future Lies Across the Ponds Airbus Global Market Forecast Annual Traffic Growth: 2009-2028 Boeing Current Market Outlook Annual Traffic Growth: 2009-2028 4.6 4.9 NorthAm to LatAm Transpacific 4.0 4.7 North Atlantic 6.8 4.2 2.5 www.airlines.org Within NorthAm China-US Japan-US US-Europe Domestic US 2.0 32 Healthy Investment Requires Healthy Equity Equity Market Capitalization (Billions) as of Jan at 1800 EST eBay $37.5 U.S airline industry* $40.9 Deutsche Bank Goldman Sachs BP Toyota Wal-Mart GE Microsoft Apple ExxonMobil www.airlines.org * AAI, ALGT, ALK, AMR, DAL, HA, JBLU, LCC, LUV, PNCL, RJET, SKYW, UAL $50.9 $89.0 $125.8 $145.6 $193.8 $198.4 $239.6 $306.4 $376.7 33 AAA www.airlines.org BBB BBBBBB+ B+ B B BBBBBB- Southwest Lufthansa British Air Alaska TAM Delta United Air Canada AirTran American JetBlue SAS US Airways A Goldman Sachs BBB A eBay QANTAS A BP AA Wal-Mart GE AA AA+ Microsoft Toyota AAA ExxonMobil Healthy Investment Requires Healthy Credit No Passenger Airline in the World Enjoys an A-Minus or Better Rating from S&P >= BBB- (investment-grade) < BBB- (speculative or “junk”) 34 S&P Corporate Credit Ratings (July 12, 2010) for North American Transportation Companies, “Strongest to Weakest” AA- to A- BBB+ to BBB- BB to B B- to CCC- 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 Union Tank Car UPS TTX AMTRAK Canadian National Railway Kirby Corp www.airlines.org Burlington Northern Enterprise Holdings Norfolk Southern Ryder System Alexander & Baldwin GATX Union Pacific FedEx Hunt (J.B.) Transport Brink's Co Aviation Capital Group Canadian Pacific Railway Southwest Airlines CSX Con-way ILFC AWAS Aviation Capital Teekay Corp AMERCO Kansas City Southern Mobile Mini Inc Overseas Shipholding Group Kenan Advantage Group RailAmerica Avis Budget Group US Xpress Enterprises Hertz Global Holdings Alaska Air Group Global Aviation Holdings Marquette Transportation United Maritime Group Delta Air Lines Ozburn-Hessey Holding Co American Commercial Lines Horizon Lines General Maritime Corp Continental Airlines Dollar Thrifty Automotive UAL Corp Coach America Holdings JetBlue Airways AirTran Holdings JHCI Acquisition Inc Quality Distribution Inc Trailer Bridge Inc Western Express Inc AMR Corp US Airways Group Air Canada Swift Corp Evergreen International YRC Worldwide 35 What’s Wrong With This Picture? The Investor’s View ―As you weigh policy objectives for the airlines, you may want to consider the benefits from having airlines in a better position to generate a return on invested capital in excess of their cost of capital through a full business cycle The balance between positions which seek to socialize aspects of the airline industry versus those that promote growth in the free market will contribute to how the market prices airline capital risk and measures the required rate of return to justify growth The ability to generate more consistent returns on equity and increase free cash flow is the path to repairing balance sheets and longer term financial stability Only then will there be a solid foundation for increased capital expenditures, rising wages, and increased service.‖ Statement of David R Strine before the House Subcommittee on Aviation, ―Consolidation In The Aviation Industry, With A Focus On The Proposed Merger Between United Airlines And Continental Airlines – A Perspective From Within The Financial Markets‖ (June 16, 2010) www.airlines.org 36 Global Context: Airlines Challenged to Cover Cost of Capital ROIC Below WACC Translates to Loss of Investor Wealth 12 Cost (WACC) 10 Percent Return (ROIC) 2015 2014 2013 2012F 2011F 2010E 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 Source: IATA (1993-2004 from McKinsey study) and Deutsche Bank Global Research (for 2010-2012 estimates) www.airlines.org 37 Where Do We Go From Here?  To invest in people and product, airlines require sustained profitability – they must earn their cost of capital over the entire business cycle  U.S airlines are climbing out of a deep hole – doing better financially should not be equated with doing well (or well enough) financially  By just about any measure, U.S airlines are less equipped than other airlines and other industries to compete effectively on the global stage  Barriers to exit, higher taxes, environmental charges, inefficient infrastructure (air traffic control vs air traffic management) will exacerbate inadequate financial condition and the competitiveness gap  Consistent with DOT mission, promoting and encouraging the development of a viable, competitive U.S airline industry is in our national interest www.airlines.org 38 When America Flies, It Works www.airlines.org ... Members AirTran Airways Alaska Airlines American Airlines United Airlines* Delta Air Lines Hawaiian Airlines JetBlue Airways Southwest Airlines US Airways ABX Air ASTAR Air Cargo Atlas Air Worldwide... Industry Is Good for The Country, Fueling Jobs and Economic Growth “Aviation is the glue that keeps the global economy together Without widely accessible and well-priced air travel, the global economy... least ensure equality with foreign air carriers, including the attainment of the opportunity for air carriers to maintain and increase their profitability in foreign air transportation (16) ensuring