I can’t think of a sector more vulnerable to soaring oil prices than the airlines. Every dollar increase in the price of a barrel of jet fuel adds more than $1.3 million to the daily operating expenses of the U.S. airlines industry. 

The auto sector comes close, especially companies like GM, Ford, and Chrysler that depend heavily on truck sales. But at least auto companies can change their mix of vehicles to adapt to high gas prices. They may not be able to sidestep all the pain of high gas prices, but at least they have options.

So what options do the airlines have? They’ve already cut costs to the bone. And from the feedback I’ve received, it seems like they’ve royally pissed off passengers and employees alike.

IDE reader, Wayne said I shouldn’t be pointing the finger at unions or the costs of legacy benefits: “…most U.S. legacy carrier employees have had their incomes slashed by at least 40% and have either watched as their pensions were frozen or dissolved.  Along with the pay cuts, premiums on health care doubled, work rules returned to the dark ages, and even crew meals were eliminated.”

Sadly, Wayne is right. Employees have taken it on the chin.

But other readers say it’s the passengers who are taking it on the chin. Jean-Antoine, for one, resents how passengers are being treated. He says, “whilst we are being asked to pay (and it’s only normal) for our transportation costs, we are treated like rotten meat. Some one or two decades ago the airlines were going out of their way to make you feel happy to board an airplane. Nowadays you are being engulfed in huge airports where nobody can give you proper directions… where the personnel is overworked, most of the time disagreeable and often not concerned…”

Harsh words from Jean-Antoine but he wasn’t the only one who took this view. Can anybody disagree that there’s been a sharp deterioration of services? It’s pretty clear that customers don’t get the attention, food, and friendly service they used to get.

Just yesterday, United announced it’s going to ground 94 (64 in addition to the 30 previously stated) 737 jets, plus some of its bigger 747’s. What’s more, they’re expected to announce more employee reductions on top of the 500 they’ve already said they would cut.

Airlines have disaffected their two most important constituencies: employees and customers, and what do they have to show for it? Not much. Their collective backs are still up against the wall…

The question is: can they do anything now to avoid downsizing?

Hubs are expensive to maintain. Can they simply drop some of their money-losing hubs? Can they go further and adopt the low-cost carrier model?

The big problem with this line of thinking is that high fuel prices are sabotaging the profits of the low-cost carries too.

Whether legacy or low-cost, you can’t fill half or three quarters of a plane with people at 1988 prices, have it run on jet fuel that costs $161 a barrel, and make money.

The reality is that lots of low-cost airlines have also struggled. In the past six months, at least a dozen airlines have failed as oil rose. American companies ATA, Frontier, Skybus and Aloha Airlines have all filed for chapter 11 bankruptcy protection this year.

In all, about two dozen low-cost carriers and other non-legacy carriers have filed for bankruptcy or gone out of business since 2000.

But listen, retailers, restaurants, high tech and industrial manufacturers fail all the time. The airline industry has simply proved not to be the exception. And higher fuel prices are sure to increase the rate of failure (or bankruptcy) in this sector.

As Stephen Ridgeway, the chief executive of Virgin Atlantic Airways, recently said, “The good times are over.”

Let the downsizing begin. Only then can supply and demand rebalance and ticket prices start to rise. There’s no other cure.

Good Trading,
Andrew Gordon

P.S.  To let me know what you thought of today’s article, send an e-mail to: feedback@investorsdailyedge.com.

Source: Airing It Out