Over the past two months, I have reported on weakening unit revenue trends within the airline industry. While the industry bottomed out in April, results in May were still fairly unsatisfactory at most carriers. Airlines are benefiting somewhat from lower fuel prices and planes are more packed than ever before, but pricing power has been extremely weak. As a result, most carriers suffered a second straight monthly decline in unit revenue.
|Airline||Unit Revenue Change||Capacity Change|
|Amr Corp. (OTCBB:AAMRQ)||Down 1.8%||Up 0.3%|
|Delta Air Lines, Inc. (NYSE:DAL)||Up 0.5%||Up 0.7%|
|Southwest Airlines Co. (NYSE:LUV)||Down 2.0%||Up 3.4%|
|United Continental Holdings Inc (NYSE:UAL)||Flat-Down 1.0%||Down 1.7%|
|US Airways Group Inc (NYSE:LCC)||Down 1.0%||Up 3.6%|
Unit revenue is a very important indicator of performance for airlines, because it includes the effects of both “load factor” (the percentage of seats filled with paying passengers) and “yield” (the average ticket price). For several years, airline industry unit revenue had shown continuous growth as the U.S. economy rebounded from the Great Recession. However, that trend seems to have been broken this spring. If unit revenue continues to stagnate, airlines will have trouble producing meaningful profit growth.
Where’s that capacity discipline?
Much of the bull case for the major airlines has been built on the premise that consolidation has improved capacity discipline and pricing power within the industry. As CNBC’s Jim Cramer put it, the U.S. airline industry is essentially an “oligopoly”. Assuming that the American-US Airways Group Inc (NYSE:LCC) merger is completed, four airlines will control more than 80% of the domestic market. That fact formed the basis for Cramer’s buy recommendation on the sector.
The past few months of revenue results have thrown cold water on the theory that consolidation has significantly improved capacity discipline or pricing power. Most major airlines have been replacing smaller planes in their fleets with larger ones, which is making it difficult to prevent capacity creep. For example, while Southwest Airlines Co. (NYSE:LUV)’s capacity increased 3.4%, it actually few 2.3% fewer trips last month than it did in May, 2012. In other words, the capacity growth was the result of larger planes making longer flights: not operating more flights.