Over the Long Haul, Airlines Are a Vital Business
How rapid is change in business today? A reported comment questioning whether the airlines--one of the leading industries of the 20th Century--could ever really be a good, substantial business caused airline stocks to sink last week.
Noted investor Warren Buffett later denied he made such a comment, but the point is that Wall Street didn’t need to check. Professional investors agreed with the sentiment that the airlines had become a low-profit, commodity industry.
All the shining projections of growth in vacation and business travel mean little in the market these days. Even the competitive success of the U.S.-based airlines, American, United and Delta in international markets cuts no ice.
And such pessimism seemed to be confirmed last Thursday, when Southwest Airlines, the efficient, competitive company that had become the darling of Wall Street and of thrifty passengers, said that profits would be off sharply in the fourth quarter. Southwest’s stock price, already down this year to $20 a share from $39, fell 15% on that day. The stock closed Friday at $17.25 a share on the New York Stock Exchange, up 12.5 cents.
The problem, said Southwest, was renewed fare war competition, from United’s cut-price shuttle in California and from aggressive new airlines entering the business.
Fare wars, even in a holiday season with passenger traffic growing almost 5% this year? Does the airline business, indeed, make any sense?
The answer is yes, but fasten your seat belts. It is a wildly active business these days, full of innovation and entrepreneurship but still full of promise for some of the traditional big lines.
To understand how energetic the business is these days, look at Wall Street’s newest darling, ValuJet Airlines. Founded in Atlanta less than 14 months ago by four airline executives in their 40s, ValuJet is already tearing up markets in the Southeast and ambitious to grow into the Middle West.
It has 17 DC-9 airplanes in its fleet and will soon have 27, bought on five-year credit from McDonnell Douglas. ValuJet flies to 17 cities for fares of $39 to $59 a trip, with no tickets. Computers assign confirmation numbers to passengers, who pay by credit card and board the plane, where it’s first-come, first-served for seats.
Such no-frills service and very low labor costs keep ValuJet’s costs a shade under Southwest’s but a third less than the average cost of full-service airlines.
ValuJet has come on fast. In the nine months ended Sept. 30, it grew to $86 million in revenue and earned $13.8 million in net income. Since going public on Nasdaq in June, its stock has gone from $12.50 a share to about $23. On Friday it closed at $22 a share, off 50.25 cents.
What does that burst of success tell us about business in America today? That there are a lot of skilled people out there, many from the shrinking defense industry and armed forces, willing to work for less money. ValuJet pays mechanics $8 to $12 an hour--half to two-thirds of what other airlines pay. It pays pilots about $43,000 a year, a lot less than other airlines pay.
But it pays bonuses, which can add one-third of pay, to all employees based on the growth of the business. And its rapid growth creates opportunities for people to move up quickly. “It’s a young company,” says one employee in his 20s.
ValuJet’s success also tells us there are a lot of investors eager to back start-up companies. Chairman Robert Priddy, President Lewis Jordan and Las Vegas investors and former airline owners Maurice Gallagher and Tim Flynn put up $3.4 million and were able to attract $73 million more through private and public sales of stock.
It tells us of the unpredictability of business. ValuJet’s DC-9s are old planes, supposedly unusable because of noise regulations. But in response to the need, several small companies have developed engine adaptations, called hush kits, which cost almost half as much as a whole airplane but allow them to meet regulations.
So ValuJet is adding destinations in Detroit and Miami, and bringing further pressure on troubled USAir Group, in which Buffett invested $358 million five years ago in the belief that regional airlines had a bright future.
The so-called Sage of Omaha was right on that count. Southwest and its many imitators, including ValuJet, have all succeeded regionally. But they have operated efficient, low-cost operations while Buffett’s USAir has one of the highest cost structures in the business. Buffett’s mistake was not comparing costs and anticipating change.
But does the success of low-cost regionals mean the whole business falls to no-frills operators, that the traditional industry is a dodo bird? No, not at all.
Such airlines, offering no connections with other flights, are limited to short hauls to begin with. And there can be problems in growth and low wages. A mechanic earning $8 an hour to start and having to certify the airworthiness of planes may be getting paid too little for such responsibility. Nurses came in short supply years ago when their wages got out of whack. Southwest, it should be noted, pays better than the industry average on an incentive basis.
The major airlines are responding to the challenge, becoming leaner in their own operations and also relinquishing some routes to the newcomers to concentrate on longer hauls and bigger markets where they can make a profit. What we’re getting is a mix of services, depending on distance and time, price and comfort.
Lee Howard of Airline Economics, a Washington consultant, notes that low-cost regionals, including Southwest, carry less than 10% of airline traffic. And with travel picking up, the big carriers, notably American, are returning to steady profitability.
Also, the biggest and most overlooked point of all is that passengers are winning big, from lower fares to extra travel options domestically and internationally.
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So consider the airlines: A business attracting investments, entrepreneurs, customers and ambitious workers and fostering innovation and competitive operations at home and abroad. If that isn’t a healthy industry, what is?
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Fall From Grace
Airlines have been gliding down all year and last week tumbled further on a reported comment by Warren Buffett and Southwest Airlines’s gloomy earnings projections.
Southwest Airlines
Friday close: $17 1/4
American Airlines
Friday close: $49 7/8
