Why inflation causes turbulence for the airlines

It’s hard times for airlines right now. In fact, the industry’s stock index is down by one-third over the past 12 months. That’s hard to take, considering that the broader market is down around 13% over the same time.

This shouldn’t be the case. After all, the Department of Transportation has documented that passenger volumes are up – way up, like 70% – over a comparable period. All the majors were adding flights and even adding routes. The average ticket price – which had declined annually for six straight years – rose 17.6% in 2021. More recent figures show that airfare prices have risen at close to triple the overall inflation rate.

And yet, other airlines are going bust. Scandinavian Airlines recently declared bankruptcy. This move immediately grounded half the fleet of the 75-year-old SAS, making it the ninth carrier to prove insolvent in 2022.

It’s not hard to identify a proximate cause for the airlines’ problems. If it’s not a lack of revenue, then it’s got to be a rise in costs. In short, both sales volume and sales prices are going up, but the expense of filling those seats is going up even faster.

Crew Cuts

It’s not just the cost of one thing going up. It’s pretty much everything. Let’s start with what sank SAS: payroll. As with everything else that’s in demand, scarcity breeds higher costs, and, for many reasons, it’s not so easy to assemble an aircrew.

During the pandemic, when passengers were nonexistent, SAS did what all other airlines did: lay off workers. Of its 12,000 employees, 5,000 were severed. Many were hired back as air travel resumed, but labor markets had taken a swing favorable to the employees and, last week, hundreds of SAS pilots and mechanics walked off the job.

It’s a similar story with the U.S. carriers. In May 2020, 50,000 airline layoffs were prevented by a federally funded payroll support program. That kept the checks coming for five months, at which point those jobs were put on hiatus for several weeks until another covid relief package was passed.

By the time that money was spent, the airline industry was well on its way to recovery thanks in part to what has come to be known as “revenge travel,” by which consumers with pent-up demand have splurged on longer and more lavish vacations without regard for inflated prices. But you know that whole “dynamic pricing” algorithm that adjusts ticket prices to what the market will bear? That doesn’t work for pilots’ wages. You simply can’t dial a skilled workforce up and down like you’re on Expedia.

When there were no flights, there were no flight classes. Training and recertification bottlenecks have been widely reported in the trade journals, although not so much in popular news outlets. Still, Axios has a good summary. According to the article, airlines are throwing all the money they can at the problem by offering retention bonuses – to the same people the airlines had offered sweet early retirement deals – and flight school scholarships.

But it takes more than money. It takes time, and that is in short supply. Labor Department figures suggest that, for the next several years, there will be two job openings for every new pilot. While it can take months to turn out a new pilot, there’s also a mandatory retirement age for that individual. Currently, the sell-by date for pilots is 65 in the U.S. and most of the rest of the world. While there is some chatter in Washington about relaxing that restriction, the Air Line Pilots Association is dead set against that.

Prices at the pump … and at the plant

Wages are perhaps the single most important reason for the carriers’ higher operating costs, but it’s hardly the only one. The International Air Transport Association reports what we already knew: Jet fuel prices worldwide have essentially doubled over the past year.

Jet fuel prices are as volatile as, well, jet fuel. They already appear to be on their – slow – way down after their recent peak. And labor costs are variable to some degree; they might not be quite as flexible as the airlines would like but, in the long term, there’s some leeway. But then there are capital costs.

There’s nothing management can do about the monthly expense of an Airbus 320 that’s already in service. And there’s nothing management can do about the manufacturers’ need to pass on the rising expenses of their own labor and materials; these are generally baked into the purchase agreements under the heading, “Price Escalation Terms”.

On top of the actual cost of the aircraft is the financing cost. If an airline purchased a jet for a fixed interest rate when rates were low, it’s in a good position. If it went with a variable rate, though, that could be bad news in this time of rising lending costs. What’s true for purchases is also true for capital leases, and what’s true for original airframes is also true for replacement parts.

Fasten your seat belts   

Because of inflation, the airlines are facing some strong headwinds. How much worse things can get and how long the turbulence will last is unknown. On the one hand, the issue with fuel costs might soon resolve itself but, on the other, the labor shortage is likely to last for years and result in permanently higher costs. Will overall inflation continue to drive manufacturers’ prices? How high will the Federal Reserve ratchet up interest rates? These are two big questions.

The fact remains, though, that airline stocks are beaten down at the moment. They’re bound to come back, but will they be worth the wait? Should you be investing even more heavily now that they’re relatively cheap, or are there better investments to be made before the carriers are once more in favor of Wall Street?

If you would like to learn more about how we can help you navigate your financial future during this uncertain time, contact us today.