The three global US airlines—American Airlines, Delta Air Lines and United Airlines—appear to be bringing growth to a near halt through next year, with little-to-no growth in the domestic market and only marginal international growth expected through the end of 2017. Delta has already capped system capacity growth at 1% for the 2016 fourth quarter and all of 2017. American’s system capacity is expected to be flat in the fourth quarter and grow just 1% in 2017, including no domestic growth next year. United will end up growing full year 2016 capacity just 1.2% to 1.4% and, while it hasn’t given specific guidance on 2017, it is unlikely the carrier will grow much next year. If US carriers are so healthy from a net profit standpoint—American, Delta and United posted nearly $3 billion in combined net income in the 2016 third quarter—why are they forswearing growth in 2017? Three reasons:
1. US airlines desperately need to get unit revenue back to positive growth. Delta CEO Ed Bastian said recently that the US airline industry is experiencing the “weakest revenue environment in recent memory.” Bastian said a lack of pricing power, not weak demand, is the cause of the weak revenue environment. Indeed, US air fares are set to fall by more than 5% for the second straight year in 2016. Since late 2014, airline unit revenue—as measured in either RASM or PRASM—has consistently declined on a year-over-year basis quarter after quarter.
Wall Street has punished airlines for this. As much as airline executives want to dismiss unit revenue as a short-term metric that isn’t very meaningful long term, sustained declines in unit revenue simply aren’t acceptable to airline shareholders. So 2017 is all about returning to positive unit revenue growth for the major US airlines. As Bastian said, “capacity is a significant lever” airlines can pull to affect unit revenue performance. If the airlines stop growing, a relatively strong demand environment should lead to increased pricing power, meaning higher fares and rising unit revenue. If American, Delta and United accomplish nothing else in 2017, they want to get back to positive unit revenue growth—not growing is probably the best way to get that result.
2. Labor costs are rising. We appear to be entering a period of labor peace in the US airline industry, but that peace has come at a cost. American’s expenses, for example, increased 5.2% year-over-year in the third quarter, driven primarily by higher labor costs. New labor contracts mean carriers’ cost base is going to rise, and 2017 will be a year of adjustment in that regard. So not growing is a way to keep some control over those costs—more capacity would mean more employees are needed and those employees’ compensation would be higher than it would have been a year ago or two years ago.
3. There is a feeling among US airline executives that fuel prices bottomed out earlier this year and will only keep rising. “Year-over-year fuel prices are expected to be higher for the remainder of the year,” American CFO Derek Kerr said Oct 20. Year-over-year gains in fuel costs have probably been exhausted. Airlines’ fuel costs in 2017 probably won’t drop much compared to 2016, and may very well increase. US airlines have achieved strong profits in a low fuel-cost environment. While US airline industry leaders like American chairman and CEO Doug Parker insist profitability will persist even if fuel prices rise, the carriers have to prove it. Not growing is one way airline executives can ease their nerves about rising fuel costs.