U.S. airlines are asking shareholders to believe they can raise ticket prices while ramping up the supply of seats. To Wall Street, that sounds like a fairy tale.
Six attempts at broad-based fare increases have failed in the last two months, most recently a bid last week by Delta Air Lines Inc. The last successful widespread price hike was Oct. 10, said JPMorgan Chase & Co. analyst Jamie Baker, even as oil prices rebounded from a three-year slump.
That’s creating a confidence crisis for investors, who last week sent airlines to the biggest drop since 2015 when United Continental Holdings Inc. announced an aggressive expansion plan. The No. 3 U.S. carrier is hardly alone. Southwest Airlines Co., JetBlue Airways Corp. and Alaska Air Group Inc. are also planning to grow faster than the economy.
The worry is that the only way to generate enough demand to fill the new seats is by cutting prices. And that risks triggering fresh fare wars just as profits are under pressure from rising fuel costs.
“Capacity is starting to increase faster than demand,” said Samuel Engel, senior vice president at consultant ICF. “At that point any one carrier starts to say, ‘I’d rather add capacity and try to steal share than support a fare increase across the industry.’”
A Standard & Poor’s airline index is still 10 percent lower than before United disclosed its growth plans. The gauge fell 2.7 percent at the close in New York.
Fare Wars
It’s a competitive business, and one carrier’s attempt to raise fares can be another’s opportunity to win new customers with bargain prices. But one reason investors including Warren Buffett have bought airline shares is the expectation that after years of industry consolidation, carriers will be able to maintain steady profits, thanks in part to stronger pricing power.
Delta and American Airlines Group Inc., the two biggest carriers, have slowed their expansion in recent years to let demand catch up with supply -- and make it easier to charge more for tickets. They’re only boosting capacity 2.5 percent this year, roughly in line with growth expectations for gross domestic product, a barometer of travel demand.
A slower seat expansion helped defuse fare wars that began in 2015 and flared up again last summer before subsiding later in the year. And with the improving economy, it’s possible airlines will still be able to boost passenger revenue for each seat flown a mile, a proxy for pricing power, despite all the capacity growth.
“We think the fare environment will be strong enough to offset higher-than-expected capacity growth out of United,” David Vernon, an analyst at Sanford C. Bernstein & Co., said in a note Wednesday. “The fare environment will surprise to the upside against now lower expectations through the first three quarters of 2018.”